Investor Penalties

Accuracy Related Penalty (R&TC Section 19164)

Description

This explanation only covers the changes made to the substantial understatement threshold provisions.
The penalty is not imposed on the portion of the understatement relating to an item that is subject to the reportable transaction accuracy related penalty (R&TC Section 19164.5) or the noneconomic substance transaction understatement penalty (R&TC Section 19774).

Amount

FTB may impose the 20% penalty on the underpayment of tax caused by one or more of the following:

Negligence or disregard of rules or regulations;

Substantial understatement of income tax;

Substantial valuation misstatement;

Substantial overstatement of pension liabilities; or

Substantial estate or gift tax valuation understatement.

Substantial Understatement Threshold

Corporate threshold: The threshold for imposing the penalty for corporations, other than S corporations, is the lesser of:

10% of the tax required to be shown on the return (or, if greater, $2,500), or

$5 Million.

Threshold for all other taxpayers: The threshold for imposing the penalty for all other taxpayers remains 10% of the tax required to be shown on the return for that year or $5,000, whichever is greater.

When Penalty Does Not Apply

Noncorporate Taxpayers and Corporate Taxpayers: The understatement with respect to any item attributable to a tax shelter item may be reduced by a showing of reasonable cause and good faith under IRC Section 6664(c)

The 20% penalty for substantial understatement is not imposed on the portion of the understatement relating to an item that is subject to the noneconomic substance transaction understatement penalty or the reportable transaction accuracy related penalty.

List of Abusive Tax Shelter Positions

FTB may prescribe a list of abusive tax shelter positions where there is no substantial authority or reasonable belief an item's tax treatment is more likely than not the proper tax treatment. FTB must publish the list on its website and in FTB notices or other published positions.

Effective Date

The modifications discussed above apply for taxable years beginning on or after January 1, 2005.

Interest Based Penalty (R&TC Section 19777)

Description

This penalty applies to a taxpayer who has a deficiency and whom FTB contacted regarding the use of an abusive tax avoidance transaction.
An abusive tax avoidance transaction (ATAT) means any of the following:

Tax shelter as defined in IRC Section 6662(d)(2)(C),

Reportable transaction, as defined in IRC Section 6707A(c)(1), with respect to which the requirements of IRC Section 6664(d)(2)(A) are not met,

Listed transaction as defined in IRC Section 6707A(c)(2),

Gross misstatement with the meaning of IRC Section 6404(g)(2)(D), or

Any transaction to which R&TC Section 19774 applies.

Amount

The penalty is equal to 100% of the interest payable on the underpayment from the ATAT. The interest payable is computed from the original due date of the return to the date of the notice of proposed assessment.

For taxpayers who file an amended return reporting an ATAT after contact by the FTB regarding the ATAT but before a notice of proposed assessment is issued, the amount of the penalty is 50% of the interest payable on the underpayment from the ATAT reported on the return.

If the FTB issues a notice of proposed assessment with respect to an ATAT after the taxpayer files an amended return reporting an ATAT, the penalty is 100% of the interest payable on the additional tax attributable to the ATAT in excess of the additional tax shown on the amended return.

Effective Date

This penalty is in addition to any other penalty provided by law and applies to notices mailed on or after March 24, 2011 and to amended returns filed on or after June 23, 2011, for taxable years in which the statute of limitations for mailing notices of proposed assessment has not expired as of the date of the notice.

This penalty is imposed for an understatement attributable to any transaction that lacks economic substance. The penalty is also imposed if an entity is disregarded because it lacks economic substance. A transaction is treated as lacking economic substance if the taxpayer does not have a valid nontax business purpose in entering into the transaction.

For notices of proposed assessments mailed beginning March 24, 2011, the following changes to Section 19774 apply:

The definition of "noneconomic substance transaction" includes any disallowance of claimed tax benefits by reason of a transaction lacking economic substance within the meaning of IRC Section 7701(o).

If a penalty has been assessed for federal income tax purposes under IRC Section 6662(b)(6) on an underpayment attributable to the disallowance of the claimed tax benefits by reason of the transaction lacking economic substance, the FTB shall impose a penalty under Section 19774 on the portion of the understatement attributable to that transaction. The FTB cannot abate the penalty unless the taxpayer can establish that the imposition of the federal penalty for the underpayment attributable to the transaction was clearly erroneous.

Amount

General Provisions: The penalty is 40% of the understatement of tax.
Transactions Adequately Disclosed: If the transaction is adequately disclosed on the return (or a statement attached to the return) the penalty is decreased to 20% of the understatement of tax.

Rescission and Appeal of Penalty

Only FTB's Chief Counsel may compromise all or any portion of the penalty once the penalty has been assessed. The taxpayer cannot appeal or challenge the Chief Counsel's refusal to compromise the penalty before the State Board of Equalization or in court.

The taxpayer may also contest the penalty after paying the full amount and filing a claim for refund with the FTB. The taxpayer may appeal to the State Board of Equalization or file an action in court after the refund claim is denied or deemed denied.

The reportable transaction accuracy related penalty applies only to understatements related to reportable transactions and listed transactions as defined in IRC Section 6707A(c).

Description

This penalty applies to understatements of tax attributable to either listed transactions or other reportable transactions with a significant tax avoidance or evasion purpose.

Amount

General Provisions: The penalty is 20% of the understatement attributable to a reportable transaction or listed transaction.

Transactions Not Adequately Disclosed: If the reportable transaction or listed transaction is not adequately disclosed on the return, in accordance with the regulations prescribed under IRC Section 6011, the penalty is increased to 30% of the understatement of tax.

When Penalty Does Not Apply

The 20% penalty is not imposed with respect to any portion of an understatement if it is shown there was reasonable cause and the taxpayer acted in good faith. Such a showing requires all of the following:

Adequate disclosure of the relevant facts affecting the tax treatment of the item in accordance with the regulations prescribed under IRC Section 6011 (or the FTB rescinds the penalty for failure to disclose under R&TC Section 19772).

Substantial authority for the claimed tax treatment.

Reasonable belief by the taxpayer the treatment was more likely than not the proper treatment based on the facts and law as they existed at the time the taxpayer filed the return. The reasonable belief must also relate solely to the taxpayer's chances of success on the merits and cannot take into account the possibility that a return will not be audited, the treatment will not be raised on audit or such treatment will be resolved through settlement if it is raised.

Opinion of Tax Advisor: A taxpayer may rely on an opinion of a tax advisor in establishing reasonable belief with respect to the item's tax treatment. However, a taxpayer may not rely on an opinion of a tax advisor if the advisor:

Is a material advisor under IRC Section 6111, as amended, who participated in the organization, management, promotion, or sale of the transaction or is related to any person who so participates, or

Has a financial interest with respect to the transaction whether it is compensation directly or indirectly from the material advisor, fee arrangement, or any other continuing financial interest.

A taxpayer also may not rely on an opinion if the opinion:

Is based on unreasonable factual or legal assumptions;

Unreasonably relies on representations, statements, findings or agreements of the taxpayer or any other person;

Does not identify and consider all relevant facts; or

Fails to meet any other requirement as the IRS or FTB may prescribe.

If the taxpayer fails to disclose the transaction on their return, there is no reasonable cause exception.

This penalty also does not apply to any understatement where the noneconomic substance transaction understatement penalty applies.

Rescission and Appeal of Penalty

FTB's Chief Counsel may rescind all or any portion of the penalty for a reportable transaction, other than listed transaction, if the taxpayer meets certain criteria. The taxpayer cannot appeal or challenge the Chief Counsel's refusal to rescind the penalty before the State Board of Equalization or in court. There is no provision for FTB to waive or abate the penalty for listed transactions.

The taxpayer may also contest the penalty after paying the full amount and filing a claim for refund with the FTB. The taxpayer may appeal to the State Board of Equalization or file an action in court after the refund claim is denied or deemed denied.

Effective Date

This penalty applies to tax years beginning on or after January 1, 2005.

FTB may impose a penalty on taxpayers with taxable income greater than $200,000 who fail to meet the disclosure requirements under R&TC Section 18407.

Amount

General Provisions: This penalty is $15,000 for each failure to disclose a reportable transaction, other than a listed transaction, on a return or statement.

Listed Transactions: If the failure to disclose involves a listed transaction, the penalty amount is $30,000.

Statute of Limitations

There is no statute of limitations for imposing this penalty.

Rescission and Appeal of Penalty

FTB’s Chief Counsel may rescind all or any portion of the penalty for failing to disclose a reportable transaction, other than a listed transaction, if the taxpayer meets certain criteria. The taxpayer cannot appeal or challenge the Chief Counsel's refusal to rescind the penalty before the State Board of Equalization or in court. There is no provision for FTB to waive or abate the penalty for failing to disclose a listed transaction.

The taxpayer may also contest the penalty after paying the full amount and filing a claim for refund with the FTB. The taxpayer may appeal to the State Board of Equalization or file an action in court after the refund claim is denied or deemed denied.

Effective Date

This penalty is in addition to any other penalty provided by law and applies to taxable years beginning on or after January 1, 2005. FTB will not impose the penalty for California listed transactions entered into prior to September 2, 2003 unless that transaction meets one of the other categories of reportable transactions as defined under Treasury Regulation Section 1.6011-4.

Promoter and Material Advisor Penalties

Failure to Maintain List of Advisees Penalty (R&TC Section 19173)

Description

FTB will impose a penalty on the material advisor for failure to provide a list of advisees upon request. However, for listed transactions the material advisor must automatically provide the list of advisees to the FTB by the prescribed due date under R&TC Section 18648.

Amount

General Provisions: If the failure to maintain or provide an advisee list involves reportable transactions, other than listed transactions, the penalty amount is $10,000 per day for each day after the 20th business day of FTB's written request to make the list available.

Listed Transactions: If the failure to provide an advisee list involves listed transactions, the penalty amount is the greater of $100,000 or 50% of gross income that the material advisor derived from the activity.

Statute of Limitations

The statute of limitations for imposing the penalty is 8 years after the material advisor failed to maintain or provide a list of advisees (as required under R&TC Section 18648).

Rescission and Appeal of Penalty

FTB’s Chief Counsel may rescind all or any portion of the penalty for reportable transactions, other than listed transactions, if the taxpayer meets certain criteria. The taxpayer cannot appeal or challenge the Chief Counsel's refusal to rescind the penalty before the State Board of Equalization or in court. There is no provision for FTB to waive or abate a penalty involving listed transactions.

The taxpayer may also contest the penalty after paying the full amount and filing a claim for refund with the FTB. The taxpayer may appeal to the State Board of Equalization or file an action in court after the refund claim is denied or deemed denied.

Effective Date

This penalty is in addition to any other penalty provided by law and applies on and after October 7, 2005.

Any material advisor failing to file an information return, or files an incomplete return under R&TC Section 18628 is subject to penalties.

Amount

General Provisions: FTB will impose a $50,000 penalty on any material advisor for failing to file an information return, or who provides false or incomplete information, with respect to any reportable transaction, other than a listed transaction, with the FTB.

Listed Transactions: If the failure to file a return involves a listed transaction, the penalty amount is the greater of $200,000 or 50% of gross income that the material advisor derived with respect to the aid, assistance, or advice provided with respect to the listed transaction before the date the information return is filed under R&TC Section 18628.

Intentional Disregard to File Return: If a material advisor intentionally disregards the requirement to file an information return, the penalty is the greater of $200,000 or 75% of gross income the material advisor derived from the activity.

Statute of Limitations

There is no statute of limitations for imposing this penalty.

Rescission and Appeal of Penalty

FTB’s Chief Counsel may rescind all or any portion of the penalty for reportable transactions, other than listed transactions, if the material advisor meets certain criteria. The material advisor cannot appeal or challenge the Chief Counsel's refusal to rescind the penalty before the State Board of Equalization or in court. There is no provision for FTB to waive or abate a penalty involving listed transactions.

The taxpayer may also contest the penalty after paying the full amount and filing a claim for refund with the FTB. The taxpayer may appeal to the State Board of Equalization or file an action in court after the refund claim is denied or deemed denied.

Effective Date

This penalty is in addition to any other penalty provided by law and applies on and after October 7, 2005.

Preparer Penalty (R&TC Section 19166)

Description

FTB will impose a penalty on a tax return preparer using a reportable transaction, listed transaction, or gross misstatement to understate their client's tax liability shown on the return.

Amount

General Provisions: The penalty amount is $1,000 if a return prepared by the tax return preparer includes a reportable transaction not properly disclosed in accordance with the regulations under IRC Section 6011, any listed transaction, or gross misstatement (within the meaning of IRC Section 6404(g)(2)(D)).

Appeal of Penalty

If the tax return preparer makes a payment of at least 15% of the penalty within 30 days of the notice and demand and files a claim for refund, the preparer may file a court action within 30 days after the FTB denies the refund claim or the claim is deemed denied, whichever is earlier.

Effective Date

This penalty applies to returns prepared after January 1, 2011.

Promoter Penalty (R&TC Section 19177)

Description

The penalty applies to any person who engages in the organization of, or sale of any interest in, a partnership or other entity, an investment plan or arrangement, or any other plan or arrangement, if the person makes, furnishes, or causes another person to make or furnish:

A false or fraudulent tax benefits statement as to a material matter; or

A gross valuation overstatement as to a material matter.

Amount

The penalty is the lesser of $1,000 or 100% of the gross income derived (or to be derived) by the person from the activity.

If the activity on which the penalty is imposed involves a false or fraudulent statement as to any matter pertaining to the entity, plan or arrangement, the penalty is 50% of the gross income the promoter derived (or to be derived) from promoting the activity.

When Penalty Does Not Apply

This 50% enhanced penalty does not apply to a gross valuation overstatement.

Appeal Penalty

If the promoter makes a payment of at least 15% of the penalty within 30 days of the notice and demand and files a claim for refund, the promoter may file a court action within 30 days after the FTB denies the refund claim or the claim is deemed denied, whichever is earlier.